Corning - Earnings Call - Q1 2012

Transcript

Speaker 4

Good morning and welcome to Corning's first quarter conference call. Jim Flaws, Vice Chairman and Chief Financial Officer, will start the call with some prepared remarks. Wendell Weeks, our Chairman and Chief Executive Officer, as well as Dr. Richard Eglen, Vice President and General Manager of Life Sciences, will join us for the Q&A. Today's remarks contain forward-looking statements that fall within the meaning of the Private Securities Litigation Reform Act of 1995. They involve a number of risks, uncertainties, and other factors that could cause actual results to differ materially. These risks are detailed in the company's SEC reports. I'd like to turn the call over to Jim Flaws.

Speaker 5

Thanks, Ken. Good morning, everyone. Hopefully, you had a chance to read the press release we issued this morning on our first quarter results. If you haven't, a copy can be found on our Investor Relations website. I'd like to begin with our key messages this morning. Two months ago, at our annual investor meeting, we announced we were facing a significant reset in the company's profit levels. The reset was primarily due to significant price declines we were experiencing in our display business over the fourth quarter of 2011 and the first quarter of 2012. We told you one of the most important objectives was to reduce the level of these very significant quarterly price declines. This morning, I'm very pleased to report we expect our glass price declines in the second quarter will be much more moderate than the average of the previous two quarters.

In terms of glass shipments, display volume was better than we expected in the first quarter. Volume in our wholly owned business was up in the mid-single digits sequentially versus our expectations of being flat. SEP volumes were down less than 10% sequentially, which was also better than our guidance of down in the low double digits. We told you at our investor meeting that in addition to needing significant slowdown in glass price declines, we also needed to continue to grow our other businesses. I'm very pleased that in the first quarter, all our other businesses grew sequentially. Specialty Materials sales were up 21%, led by the stronger-than-expected demand for Gorilla Glass. Sales in Environmental Technologies were up 12%, also more than anticipated. We also told you to reach our goal of $10 billion sales by 2014. We would supplement organic growth with acquisitions.

Hopefully, you saw our announcement to acquire a significant portion of Becton Dickinson's Discovery Labware unit. This acquisition is expected to be completed later this year and is part of our strategy of becoming a bigger, more balanced company. We're delighted with this pending transaction. Several years ago, we established a plan to grow our Life Sciences business to be a $1 billion business. We have grown organically, and with the acquisitions of Axygen, Gosselin, and MediaTech reached nearly $600 million last year. The pending purchase of BD's Discovery Labware unit will complement our existing portfolio and provide access to new customers. We believe this business will help catapult our Life Sciences segment towards its $1 billion goal by 2014. I'll share some more details on this shortly. I do want to stress this transaction will not impact our ability to increase dividends or buy back additional shares.

We have the financial flexibility to pursue additional acquisition opportunities in both Life Sciences and Telecom. For those who have not had a chance to see our balance sheet yet, we ended the quarter with $6.8 billion in cash. In summary, we are pleased with our first quarter results and our progress against our key initiatives. With that intro, I'll walk you through our Q1 results and our Q2 outlook. First quarter sales were $1.9 billion, up slightly sequentially and consistent with a year ago. Gross margin was 42.4% and lower than the fourth quarter, as we had expected. Lower gross margin in display offset improved gross margins in Environmental, Specialty Materials, and Life Sciences. SG&A was lower on a dollar and percentage of sales basis, while R&D was slightly higher.

Equity earnings of $218 million were down about 10% sequentially compared to equity earnings, excluding special items, of $241 million in quarter four. As a reminder, we had excluded a significant one-time gain that occurred at Dow Corning in Q4. Earnings per share, excluding special items, were $0.30, just slightly lower than Q4, but a material decline from a year ago. Both equity earnings and EPS, as stated here, are non-GAAP measures. You can find a reconciliation to GAAP on our website. Now I'd like to start with display. Display sales were $705 million in Q1, a decrease of 10% sequentially and versus last year. Volume was up in the mid-single digits, exceeding our expectations. Price declines over Q4 and Q1 were in line with our expectations. Q1 results were negatively impacted by the weaker yen, which averaged 79 for the quarter.

Volume in SEP was down less than 10% sequentially, which was better than we had expected, and the result of customer utilization rates strengthening in March. Equity earnings from SEP's LCD glass business were $182 million in Q1, a decrease of 5% from the fourth quarter. For your modeling purposes, SEP's first quarter LCD sales were about $730 million, a decline of 8% from the fourth quarter. As a reminder, this represents SEP's LCD sales only. Public filings will report SEP's total sales, which of course include CRT glass and other product sales. Now, I'd like to spend a few minutes discussing inventory levels and display supply chain, glass supply, demand, and retail. We have revised our estimate of Q4 supply chain inventory now that we have the final data.

We feel the Q4 number was 15.2 weeks, and the supply chain had actually reduced more inventory than we previously thought. Our preliminary estimate of inventory at the end of Q1 was approximately 15 weeks. We think the supply chain built a small amount of inventory in Q1. We will continue to monitor inventory levels, especially as we progress through the second quarter. Historically, the second quarter has been the most difficult time period for the supply chain because of the lower seasonal retail sales. In terms of glass supply and demand, we believe both were in a relative balance entering the second quarter. Regarding our own capacity, we continue to evaluate our need to bring back glass capacity for both LCD and, of course, Gorilla Glass. This time, we consider our own glass inventory levels to be at the low end of what we would consider to be healthy.

As a result, we'll likely take some measured steps to ensure we have adequate supply to meet demand. Now, turning to retail, we don't have a lot of new data. In the U.S., we're seeing growth rates that are a little higher than we had expected. This is likely driven by continued growth in larger screen TVs. However, in Europe, demand is definitely weaker, a likely reflection of the economic uncertainty there. This is an area we're going to continue to monitor. As expected, year-over-year unit sales in Japan are down due to the tough year-over-year comparisons with the Echo Point promotions last year. In China, there was an interesting dynamic this year with the Chinese New Year falling in January versus February, and therefore the promotional activity for the holiday actually started in December, leading to a strong pull in of demand.

You may recall in December, units grew 45%. This led to lower demand in January, but we are pleased to see a strong growth rate return in February. We've aggregated the months of December, January, and February to deal with the holidays changing, and the blended unit growth rate in China was 15% up. In terms of PC demand for the year, we've no change to our estimate of 4% unit growth, excluding tablets. In terms of glass demand into retail, our estimate remains at the 3.6 billion square feet. As we mentioned on our January conference call, we have a variety of cases with retail demand being above or below that point estimate of $3.6 billion, driven primarily by different economic scenarios. Lastly, in terms of our migration to Eagle XG Slim, we continue to make excellent progress.

We are well on our way to meeting our goal of more than half of our glass being shipped thin. Now, turning to Telecom, sales were $508 million, up 4% sequentially, but slightly below our expectations of being up 5% to 10%. This slight miss from expectations was due primarily to lower demand for cable products. The fiber-to-the-home and optical fiber demand grew sequentially, and while enterprise sales were consistent. Net income was $21 million, down from $26 million in Q4 and $41 million a year ago. Now, compared to a year ago, the decrease in net income largely reflects weaker submarine cable sales and an increase in project spending to support fiber-to-the-home and growth initiatives for NVN in Australia, China, and India. In Environmental sales were $263 million, up 12% sequentially, which was higher than our expectations.

In addition to the normal seasonality increase in Q1, we saw additional growth. Strong auto demand in North America drove sales of gasoline scrub substrates, and higher heavy-duty sales reflected manufacturing improvements during the quarter. Net income in Environmental jumped from $28 million in Q4 to $40 million in Q1. Specialty Materials sales were $288 million, up 21% sequentially, and much higher than we originally expected. This better-than-expected sales was due primarily to very strong demand for Gorilla Glass. We saw a surge in demand in March, which we believe was due to finishers preparing for the launch of new product models. Gross margin expanded significantly in the quarter, and the segment posted net income of $21 million versus a net loss of $105 million in Q4. Now, remember that loss in Q4 is primarily due to one-time charges.

In Life Sciences, Q1 sales were $155 million, up 8% sequentially and 8% above a year ago, driven primarily by acquisitions. As I mentioned in my opening remarks, we have great expectations for our Life Sciences business. We have been and will continue to be innovators in Life Sciences. In fact, as a result of our innovative new business platforms, such as unique cell culture vessels and novel surfaces, the business has grown organically at a faster rate than the overall industry in the past three years. It is an industry that remains very attractive to us. Life Sciences is very different from our Telecom and consumer electronic-related businesses that are more immune to economic recessions and have much less seasonality. In addition, the amount of new capital required is typically very low, which is a nice divergence from our other very capital-intensive businesses.

We're very excited about the pending purchase of BD's Discovery Labware unit. This business is currently profitable and generates cash. They have an excellent longstanding reputation in the market. In fact, even those who do not follow the Life Sciences industry have heard of Becton Dickinson and their world-class products. We could not be more excited to welcome the Discovery Labware unit into the Corning family. We expect the transaction to close by the end of this year and be accretive by 2013, including the amortization of purchased intangibles. Looking ahead to 2016, which is the end of our planned integration timeframe, we expect to reach $0.05 per share accretion, also before the amortization of purchased intangibles. We estimate synergies will contribute about half the accretion through revenue expansion, SG&A reductions, and manufacturing efficiency gains. Let me quickly highlight the revenue expansion.

If you'll recall this chart from our investor day in February, I've highlighted in blue text some key examples. First, the BD unit brings complementary products we hope will add to our sales opportunities. Additionally, we have multiple revenue synergy opportunities in adjacency areas, like biological coatings on Corning products, expanding our products like EPIC and services into the ADME toxicology. For analysts who may not know what ADME toxicology is, Dr. Richard Eglen, Vice President and General Manager of Life Sciences, is actually on our call this morning, and he can answer any of your questions you have regarding the pending acquisition and the business. Now, turning to Dow Corning, equity earnings were $35 million, down 29% compared to the equity earnings peak specials of $51 million in Q4. As a reminder, we had excluded a large one-time gain in Q4.

In the silicon business, Dow Corning did see good volume growth and much more moderate pricing pressure, which led to an increase in silicon sales. However, this is more than offset by the results at Hemlock. I'll have more commentary on Dow Corning and Hemlock in our Outlook section. Now, moving to the balance sheet, we ended the first quarter with $6.8 billion in cash and short-term investments, up from $5.8 billion from the end of the year. The increase was primarily due to the $750 million debt issuances during the quarter. The biggest outflow in the quarter was cash spending of $412 million. Free cash flow was a positive $345 million. A great start to the year as the company often experiences an outflow in Q1. We also continued our share repurchase program during the first quarter, although the pace of repurchasing was much slower than the fourth quarter.

Investors should not view our repurchasing pattern in Q1 as being less bullish. I've forwarded management to continue to believe the company's current stock price is trading at a value that is lower than the long-term value of the company. I'll not speculate on how fast we'll go through the remainder of the approved amount or what the board will decide to do next. I can tell you that given our current cash balance and cash flow expectations over the next several years, we expect to have ample financial flexibility to fund additional share repurchases, do M&A, or to increase the dividend. Regarding the BD transaction of U.S. cash, we have ample cash on hand domestically to pursue all three. That completes my remarks on the first quarter.

To summarize, I'd say we're very pleased with the first quarter performance, especially in light of the headwinds we talked about just two short months ago. Now I'll turn to the outlook, and I'll start with display. In the second quarter, volume in our wholly owned business should be consistent with the first quarter, and at SEP, volume should be up slightly sequentially. Our primary reason for these levels of expected volume is that TV demand in some areas of the world has been weak, and the supply chain has already built some inventory. As always, we can be wrong. We're monitoring panel maker utilization closely. We do expect stronger pickup in glass demand in the second half, assuming normal retail seasonality.

For glass pricing, as I mentioned in the beginning, we expect our price declines to be much more moderate in Q2 compared to the significant declines that we experienced over Q4 and Q1. As a reminder, the pattern of price declines varied in those quarters, but all customers received significant price declines over that period. Moving to Telecom, we expect sales to be up in the low to mid-teens sequentially, driven by growth across all product lines. Environmental, we expect sales to be consistent with the first quarter, strong growth in heavy-duty filters. We're forecasting softer sales in the European market for light-duty filters for cars. Specialty Materials should have another strong quarter led by Gorilla Glass. Sales are expected to be up 10% to 15% sequentially. In Life Sciences, we expect sales to be up 5% to 10%.

With Dow Corning, we expect equity earnings to be up about 40%, driven primarily by the higher volumes for both silicons and polysilicon. At Hemlock, we're anticipating the challenging price conditions in poly will continue. The global oversupply of poly, combined with the decline of subsidies for two of the world's biggest markets for poly, which are Germany and Italy, continue to impact poly pricing and solar demand. We do not expect pricing to improve until supply-demand levels return to balance and the current overcapacity situation subsides. Turning to the rest of our Q2 forecast, we expect gross margin to drop almost a percentage point. While we expect some margin expansion in Telecom and Specialty Materials, these will be offset by slightly lower margins in Environmental and Display. Display gross margin will be slightly lower, even though price declines will be much more moderate than previous quarters.

From a modeling standpoint, it typically takes a higher amount of volume increase to offset even moderate price declines. The volume levels are not enough to hold gross margin in this quarter. SG&A and R&D will be consistent as a percentage of sales in the second quarter. Equity earnings, excluding special items, will be up slightly sequentially. Our tax rate will remain around 20%. For FX, the yen has significantly weakened over the past few months. The fourth quarter, the yen to the U.S. dollar exchange rate was 77. Q1, it was 79. The month of April, it actually reached as high as 83, and today it's bouncing between 81 and 82. As a reminder, our results move with the changes in the yen to the U.S. dollar exchange rate. A weaker yen lowers our results, a stronger yen helps.

If the yen averages one point higher or lower in Q2, we estimate our sales and net income would decrease or increase by approximately $7 million. That concludes my opening remarks. Ken?

Speaker 4

Great. Thank you, Jim. I pray we're ready to take some questions for Jim or Wendell or Richard.

Speaker 7

Thank you. Ladies and gentlemen, if you have a question, please press star, one at this time. Our first question comes from the line of Ehab Gulam from Morgan Stanley. Please go ahead.

Speaker 8

Hey, guys. Thank you. It's Ehab. First of all, Jim, of course, we know what ADME stands for. It's Absorption, Distribution, Metabolism, and Excretion. I think that's what it means at least.

Speaker 5

Did you know that or did you Google it while I was talking?

Speaker 8

I Googled it. Are you kidding me? Of course, I Googled it. A couple of questions quickly. First of all, can you give us an update on the China tanks coming online and timing-wise and progress of there? You previously had talked about having 25% of your capacity offline and spoke about one of your competitors having 35% of their capacity online and that helping create a better supply-demand balance. You made some comments that your own inventory of glass was low. Did I detect that you are bringing some of that 25% back online, or are you letting the move to thin glass sort of add to your capacity? Where do you see the offline amount of capacity a quarter or two out from here?

Speaker 5

On your first question on China, we haven't had a change in this display factory in Beijing. We expect the capacity to begin coming online in Q3. We're going to only bring up a portion of the factory. We're going to be very deliberate about how much capacity that adds. Obviously, we're already shipping to our customer there from our facilities elsewhere. We will start one tank there in the third quarter. In terms of our own capacity, we're not giving out the new number. We have brought up some Gorilla Glass tanks. We are being very careful about how much capacity we have online. It's less than 25%, but we are keeping it in balance with what we see as demand. It's our feeling that the glass industry overall is doing exactly the same. We see no wholesale charge to light up a ton of capacity by our competitors.

That's why we continue to believe we're basically pretty much in line with supply and demand.

Speaker 8

Thanks. If I could just ask a follow-up on the Korea customer that you had the issue with over the last several quarters. Is that now settled? Where do you stand with them with respect to they're clearly not down to zero, but where do they stand with respect to what they were purchasing from SEP, let's say, three quarters ago? Is that now stable going forward, or do you anticipate more variations?

Speaker 5

Three quarters ago, if you're talking about the summer quarter, it should be Q3. They are purchasing at a lower level, probably not too far off of what they did in Q3, which is when we lost the share originally. Compared to Q2, it's a lot lower. They are continuing to buy from us. We continue to talk to them. As I indicated, I think actually at your conference, we are not going to give very low prices to try and gain share back.

Speaker 8

Great. Thank you.

Speaker 7

Thank you. Our next question comes from the line of Mark Suh from RBC Capital Markets. Please go ahead.

Speaker 1

Thank you. Jim, maybe if we could get a sense of the quarterly sequence of price declines in display glass. It was bad for two quarters. It sounds as if it gets better as near-term capacity is taken out of the system. Is this kind of the new norm going forward? Maybe some insights into how the negotiations for pricing proceeded and what indications that holds for pricing discussions over the longer term.

Speaker 5

Mark, we had significant price declines in Q4 and Q1 at essentially all customers. They didn't happen at the exact same time at each customer, but in the end, all customers got significant price declines. When we went for Q2, we obviously wanted to try and get back to a much more moderate price decline pattern. That's what we rolled out. We were delighted that we were able to achieve that. We think the primary precursors to allowing that to happen are, number one, that capacity is more in line with demand, and number two, that demand at retail has been okay. That has worked for Q2. We obviously haven't negotiated any pricing for Q3.

The thing for you to pay attention to is if retail demand and flowing through to the panel makers is as we expect in Q3 and Q4, and the industry continues to balance its capacity utilization from a glass point of view, that would be very favorable for pricing. Obviously, we are not giving guidance at this point in time for Q3.

Speaker 1

Okay. Jim, separately, Gorilla Glass seems to be re-accelerating. What's driving that? Is that broad-based adoption in terms of applications, or is it a concentrated customer that's kind of lifting your outlook for Gorilla Glass?

Speaker 5

I would say that we had some disappointment in the third and fourth quarter on Gorilla Glass, where we would say in the end market, the demand for smartphones and the mix of smartphones overall is quite strong, as well as tablet sales were good. That wasn't flowing through to us in quarter three and quarter four. Now we feel like we're catching back up to that. The reason why we think we are off of it was that we do know that some customers built inventory in the first half of 2011. We remember we were very tight on capacity. Also, their own yields have been improving over that period of time.

What we're hopeful of is that the demand that we saw in Q1 is more representative of us being in line with the real end market, where smartphones and tablets continue to be doing quite well at retail. That's why we hope that will continue in this second quarter.

Speaker 1

Okay. More broad-based return.

Speaker 2

Yeah. Let me just add to that in that it is broad-based, and we view that it is driving more in line with what is happening with the market. It's just important to note this is a long supply chain. It's a complicated supply chain. We take glass, we ship it to finishers, who cut it, then ion exchange it. They, in turn, ship it to a touch panel manufacturer. They, in turn, send it on to an ODM, who then assembles the whole thing. Finally, it goes to the brand, who's the person that we sold to really originally. Each of these steps has different yields, and different players have different yields, somewhere between 70% and 95%, depending on the step and depending on the player. Our market position is so strong in this, it means that classic supply chain variability, right? We're going to feel 100% of that.

That can mean, just depending on how the supply chain works, that our glass shipments in any given quarter can be different than the end market pull-through. That's what we experienced in the back half of last year. Now you see us sort of moving in line with the overall pull. We're going to continue to have some fluctuation here, not because of anything bad that's happening, but only because of the strength of our position and the length and excitement in this supply chain.

Speaker 1

That's helpful. Thank you, gentlemen.

Speaker 7

Thank you. Our next question comes from the line of Nikos Dimopoulos of UBS. Please go ahead.

Speaker 9

Yes. Thank you. A couple of questions. The first one is, in the press release, you mentioned that you think that the LCD revenues could show growth in the second half of the year. Even under a more moderate price decline environment, it would seem that in the third and fourth quarter, you would have to have roughly 15% kind of sequential increases in volumes to achieve that. What gives you confidence that that would happen? That's question number one. On Life Sciences, maybe if I look at it, it's an area I don't know that well for Corning. If I look at their other businesses, you have very high market share and leadership. When I look at this business, before you started acquiring companies, you were doing just slightly over $100 million a quarter. It didn't seem like a business you had material leadership.

Can you give me an update on what you think your market share is in this business and why the rationale in doing these acquisitions? Do you think you should become a material leader in that segment? Thank you.

Speaker 5

I'll start with display. I think what we were trying to say at the back half of the year is that the volume available for glass makers from the flow-through of retail back to the panel makers would be substantially higher, driven by the fact that the end market is seasonally stronger then. What has happened to this industry over the last couple of years is that, in fact, people don't have to build for televisions back in April for the Christmas season. They can do it much closer. What we were talking about is strength in volume sequentially compared to the first half of the year. I'll let Wendell maybe open on Life Sciences, why we find it attractive, and then ask Richard to add a few more comments.

Speaker 2

To your point on leadership, it was exactly that that we identified as the opportunity, Nikos, is that we could bring to bear some of the same things that make us be a leader in our other segments and become a leader here. Leadership in two ways that matter. I think one is innovation, where we've shown with our ability to grow organically at about twice the rate of the underlying market growth. That has been solely due to our ability to bring more innovation to bear. Also with brands. What you see us doing on the acquisition front is augmenting our already strong brand in the Discovery Labware markets with additional brands like Falcon, which are quite strong.

Global expansion also plays to our strength because we are already very strong as Corning in a lot of the markets that are going to be the real hypergrowth areas for doing more discovery work in the Life Sciences area, which is where our product strength lies.

Speaker 1

Yeah. I mean, just a few words to add to that. I mean, a good number to bear in mind is that the Life Sciences division at Corning has grown about 16% from 2006 to 2011. That's the combination of the innovation that's been brought through, as well as the strategic acquisitions, of which the proposed acquisition of the Discovery Labware business would be the fourth there. As we've grown, as Wendell says, and expanded our geographic reach, we can now move with a broad product portfolio offering into both the academic research market as well as the drug discovery market as well.

Speaker 7

Thank you. Our next question comes from the line of Amir Razi from Earthleaf Capital. Please go ahead.

Speaker 0

Yes, thank you very much. Good morning, folks.

Speaker 4

All right. Good morning.

Speaker 0

Jim, I was wondering if we could talk a bit about some of the ASP declines that you've seen. You said that there has been a reset with respect to ASP declines, obviously, and with respect to margins on your display business. With your commentary that you now expect to see sort of easing pricing declines going forward, should we now expect that largely that reset is behind us, or are you still somewhat cautious going into some of the forward quarters to see some level of stabilization here?

Speaker 5

I would say we're hopeful that we've achieved back to the moderate level. If you go back over most of the last five years, the majority of the quarters were this moderate price decline philosophy that we had brought out at the end of 2006. We're hopeful that we have, with what we've achieved in quarter two and the conditions that we think allow that, that we'll get back on that. I cannot guarantee you that we've achieved that in perpetuity. What we have done is to try and have capacity be in line with the demand. We think that allows for this more moderate price decline. We achieved it in Q2. We're hopeful that the same set of conditions will allow us to achieve it in the back half of the year. I can't make that guarantee yet.

Speaker 0

Okay. That's helpful. If I think about sort of innovation on the LCD TV market, a lot of us and investors have seen some of the developments on the OLED side at CES earlier this year. There's been a lot of talk also of possible new entrants into the TV market, perhaps bringing some of their innovation to bear from other tangential markets. I was wondering if you could give us an update on where you see sort of OLED development and its impact for you folks and whether or not you are seeing potential new entrants that could help drive further either replacement sales or some level of increased innovation that gets people a bit more excited about replacing televisions here.

Speaker 2

It's a great question because as the LCD market has been going through the great challenges and sort of maturity that it has been, what our customer base has done is to invest very strongly in new innovations. I think OLED captures a lot of the headlines, but really, it's part of an overall innovation trend around high-performance displays that are in the area of doing very high pixel count displays as well as thinner, faster refresh. OLED adds the opportunity of a little bit more dynamic color with the potential to go even thinner. These higher performance displays do two things that are helpful. First, the point you're making, which is higher performance displays encourage the market to trade up because it's more visible, literally, on what it is you're looking at.

The other is, from our perspective, it puts way more challenges on the glass itself because the way you get a higher pixel count style display is by making more complicated electronics packages, which put more stress on the glass, which offer us the opportunity to innovate. Those are, I think, the two positive forces. There's a lot of different technology nodes out there. What we're doing is covering our bets across, as you saw with the new OLED venture for glass with Samsung, who's the leader in OLEDs. As you see, when you start to hear things like Oxide TFTs, all these new backplane technologies, we're also having a significant amount of effort and innovation in that space and alliances with the leaders in that space as well.

Overall, we look at the amount of innovation in LCD right now in our display business to be really at a high. You're not going to see it in television first. Where everybody is focused is where the growth is at, which is in the same area as the Gorilla is at. That's going to tend to be in mobile displays is where you're seeing the bulk of the focus. There is work going on on TVs and large size, but I think that's going to be a little bit later as opposed to sooner in terms of the size of its impact on the display technology landscape, if that makes sense to you.

Speaker 0

That certainly is very helpful. Perhaps on the question around new potential entrants into the LCD TV market, have you folks been seeing any, or can you even comment on that?

Speaker 2

I cannot comment on the activities of any of our customers. It's for them to comment.

Speaker 0

Okay, thank you very much for the incremental calling.

Speaker 7

Thank you. Our next question comes from the line of Rod Hall from JPMorgan. Please go ahead.

Speaker 3

Yeah. Thanks for taking my question. I guess I've got two. One is a little bigger picture question about the industry. The panel industry is still not profitable and marginally profitable. I guess that's the primary reason that pricing remains so volatile and uncertain in the future. I just wonder if you guys could comment a little bit about what it is that repairs that industry profitability. Is it only demand that we have to look forward to, or are there other things that can happen that help these panel manufacturers to get more profitable so there's not so much pressure on pricing? I guess that's my first question. Just a quick housekeeping question for Jim. I didn't hear you mention the overall industry glass volume, LCD glass volume for Q1.

I wonder if I just missed that or if you didn't mention it, if you could talk about that a little bit.

Speaker 5

We didn't give out the glass volume for Q1. We've stopped giving out that level of detail about the supply chain. In terms of the panel industry, I'll start and ask Wendell to jump in. I think what we have seen over the past quarter is stabilization and slight price increases in panel prices. As Wendell was talking about, we see the industry, I think, slowing their capacity additions or actually, in some cases, stopping them. We see them focused on products that could bring them higher revenue off the bad capital, as Wendell was talking about with some of the high-performance displays. Wendell, anything you'd like to add on the industry?

Speaker 2

First, I think you're on a really excellent question in that the display industry, our customer base, are quite challenged financially. I think there's three things that they're doing to try to address that. First is getting an industry structure where you see a sweeping set of moves by a bunch of different players as they either emphasize or de-emphasize their investments in the space and consolidation. That basically is aimed at demand versus supply balance. That's where Jim is addressing. You know, the best proxy for that, usually one way or the other, is what's happening with panel prices. None of us would overreact to the latest sort of relative stability in panel price. I think we just got to look at this going forward and see how that plays out. Second is what's leading to their challenges is, first, the market wasn't as big as everybody was expecting.

Second, there's a lack of strong differentiation in the product sets. That's where you see the emphasis on innovation for high-performance displays, which, by the way, people talk about OLEDs. Note Oxide TFT technology, which is a new backplane technology, is revolutionizing what LCDs can do. It is making a faster refresh rate, much higher pixel count. It's way more dynamic displays. It is far from over on which displays are going to win in which segment. You see that strong focus on differentiation. We'll see how that plays out in the technology nodes in one area for the other. Finally, you see the focus on those areas in the market that are growing the strongest. Their profitability pools are more aimed at the smaller mobile areas. That's why you see the emphasis towards that space.

I think those are the three things that the customer base is working its way through. We'll have to see how it all plays out. Clearly, the best and most important thing that can happen in the near term is for the market, the end market, to perform in lines with our expectations and theirs. That'll certainly help create the type of environment that's a little more stable.

Speaker 5

Okay, thanks, guys.

Speaker 7

Thank you. Our next question comes from the line of Jim Suffa from Citi. Please go ahead.

Speaker 9

Thank you very much for your details. I'd like to ask that your commentary about more moderate pricing. Is that something kind of in a range of 3% to 4%? As I noticed, the company did not say like historical ranges, which have traditionally been down closer to 2%. Or put differently, is the future pricing now slightly more aggressive, or am I just being too sensitive on the wording? As I think you know I'm a sensitive guy.

Speaker 5

We think all our analysts are sensitive. Don't read too much into the wording. I will tell you that the price declines are significantly down from what we experienced in Q4 and Q1. I'm not going to give out an exact number for competitive reasons, but you'd be very pleased with the reduction in the price declines that we've had, particularly because you're a sensitive guy.

Speaker 9

Thanks. Does that take you back to your original plan? I believe it was in the 2007 time period or something where you implemented this new pricing discipline, nature of disciplined pricing. Does that take you back to that type of level? What I'm trying to get at is, are we back to that original plan of pricing or something just slightly more aggressive?

Speaker 5

I'm sorry, Jim. I'm not going to give you an exact number for competitive reasons.

Speaker 9

Okay. Maybe I can ask a different question. On the gross margin, I think I heard you mention it will be down about one point. If that's correct, does that imply that you think maybe Q2 will be the bottom for your gross margins? Will some things such as ramping China impact that going forward? I don't know if when you ramp China, are you just layering in that additional supply slowly, or will you be taking off production elsewhere and impact your gross margins?

Speaker 5

In terms of our gross margin, in terms of China, we will balance all of our production against what we think the market needs. If China came up and we didn't need it, we need the light one tank there, we would cut back elsewhere. We actually think that quarters three, which is when China would start, in quarter four, that the glass demand will be higher if we're right about the normal seasonal uptick at retail and the fact that the supply chain doesn't appear to be building excess inventories. You shouldn't, based on what we think, expect China to be a drag on the profitability of display. In terms of our gross margin as to whether Q2 is the lowest, it all depends on what we see in Q3 and Q4.

If our hopes turn out that we're back on a path of moderate price declines and we see volume grow at a greater rate in Q3, that will improve display gross margins, and that will improve our corporate average gross margin.

Speaker 9

Thank you very much.

Speaker 7

Thank you. Our next question comes from the line of Samik Chatterjee from JPMorgan. Please go ahead.

Speaker 1

Hi. Thanks. It's Simona Jankowski here. Just a couple of clarifications on your display business and then a couple of questions. I just wanted to clarify first, in terms of the upside you saw in the quarter on your volumes, was that a better demand that you saw, or was there some better share gains for you at some of your customers, particularly as you caught them up on some of the pricing? The other clarification I had was on the competitive situation at your Korea customer. Looking at that now, do you feel that that was really kind of unique and contained to that one customer, or is there anything that would lead you to believe that there could be some similar type of situation, maybe not to that same magnitude, arising at other customers? I have a couple of quick questions.

Speaker 5

The upside was better utilization by various customers. That's what was the improvement. As to our characterization of what happened in Korea in Q3 and Q4, we regard that as a very unique situation and not something that we are really experiencing elsewhere.

Speaker 1

Okay. That's helpful. Just a couple of quick questions. One, you didn't mention anything on the Olympics, and I guess we've all been kind of burnt with that in the past. If you can just give us some sense of what you're expecting or seeing in the supply chain ahead of that, if anything. Lastly, what impact, if any, do you see from the change there at Sharp in terms of Hon Hai's purchase of an equity stake in their Tenji plant?

Speaker 5

I'll take the Olympics and let Wendell take Hon Hai. We're not hearing the same buzz about the Olympics as we heard before the China one. As you know, generally, our philosophy is that sporting events create a minor uptick. It's usually less than what people's expectations are. We're actually quite pleased that people aren't getting overhyped about this. We really are not hearing the buzz like we saw in 2008 before the Olympics in China. Wendell, you'd like to comment on Sharp and Hon Hai?

Speaker 2

First, I'd like to take a little piece of the Olympics one, and then I'll move on to Hon Hai, which is actually, we were hoping that my daughter, who is a track athlete, was going to make the Olympic trials this year. I could guarantee you there was going to be a huge upsurge in television purchases here in the upstate New York region. However, she injured her ankle, so now I don't know.

Speaker 1

Sorry to hear that.

Speaker 2

Yeah. Anyway, I digress. The Hon Hai-Sharp play. Let's contain ourselves to the publicly disclosed information from Foxconn, Hon Hai, Terry Gou, basically, and Sharp because I just have to, okay? In their rationale for the transaction, what it really comes down to is Sharp is an absolute leader in display technology. They're the people that we did all the original work with LCDs. It is true. They are a leader. Earlier in the call, you heard me talking about Oxide TFT and the revolution going on for LCD. Sharp is an absolute leader in Oxide TFT, especially very large-size Oxide TFT. They have that strength.

Terry Gou says, "I have enormous market access, but I am missing the relevant technology to be able to take my market access and turn it into volume and panel plants that I have an ownership interest in." Hence the merger here or Terry Gou's investment in Sharp and in the Sakai City. The logic is he will take his market access, fill up Sakai City, and be able to take this new technology as well as some of the existing technology and be able to greatly enhance the position of the non-Korean panel manufacturing industry. That is the stated logic of the transaction. If that is indeed how it plays out, given our position in Sakai City, that would be a very favorable outcome for us.

Speaker 1

Right. In that scenario, you would expect the utilization to rise, and indirectly, you'd gain share in that situation.

Speaker 2

In that situation, if that is the way indeed that it plays out, it's early days. Sometimes industrial logic of transactions doesn't carry its way all the way through to reality. Sometimes it does, and it's better. It's just a little early for us to be able to call it definitively.

Speaker 1

All right. Great. Thank you very much.

Speaker 7

Thank you. Our next question comes from the line of Carter Shu from KeyBanc. Please go ahead.

Speaker 6

Good morning. Thanks for taking my questions. First question, assuming you increase inventory levels at the wholly owned display division in 2Q, can you comment on the magnitude of that increase?

Speaker 5

It would not be significant, such that you would notice the impact in our results.

Speaker 6

Okay. That's helpful. In response to a question by a particularly sensitive analyst, you mentioned that China won't be a drag to gross margins in the third quarter when that comes online. Are you suggesting it's not going to be a net decline in gross margins, or are you saying that the increase won't impact it at all? I know when we brought on the Gen 10 facility, obviously a much larger facility, I think it was about 2.5 points to a 2.5 point drag to corporate gross margins in the June 2009 quarter. You don't expect any drag there whatsoever. Is that accurate?

Speaker 5

My comment was I do not expect a drag on display margins in Q3 from the startup of a tank in China. Going back to the Sakai City, it was a very large facility. Remember, both the display business and Corning Incorporated were much smaller then. I don't expect to see a drag from China based on what I know today with how we're going to phase the startup.

Speaker 6

Great. Just two housekeeping questions, if I may. Did you say what Gorilla Glass sales were in the quarter? If so, I missed that. If you didn't, could you provide that?

Speaker 5

I did not, and we are not providing.

Speaker 6

Okay. On the acquisition, the BD acquisition, when you say it's going to be slightly accretive in 2013, what type of financing are you assuming in that calculation? Is that a WACC, or is that using cash financing?

Speaker 5

We did it. We're doing it all with our cash, which we earn nothing on.

Speaker 6

Okay, thank you very much.

Speaker 7

Thank you. Our next question comes from the line of George Notter from Jefferies. Please go ahead.

Speaker 0

Hi. Thanks very much. I guess if I look back on pricing historically, you've had these catch-up scenarios play out where Corning for periods of time has experienced more moderate rates of price erosion. Then we've found, you know, four or five quarters down the line that you've kind of been out of WACC a bit relative to your competitors, and you've had this catch-up period where your pricing's come down more aggressively. Do you think that scenario could play out here going forward? In other words, I'm wondering if you see everyone kind of behaving like you guys in terms of price erosion for the next few quarters.

Speaker 5

Our hope is that we are getting back to moderate price declines for ourselves. We're hopeful that that's what the entire industry is going to do. It's pure speculation for me to say how long that would last. Our hope is that it continues for a long period of time.

Speaker 6

Got it. Just.

Speaker 2

Just one other point because you're leading on the logic flow I just want to touch on, which is usually us relative to our competition. Yes, we indeed get a premium. That premium has that sort of coupled 3% range of premium that within that, we can maintain our share position at a given customer. You know, above that, pressures increase. It's not so much that our customers, we're not deliberately trying to expand that premium and that our competitors are dropping lower than us. Usually, what leads to this sort of disconnect and more catch-up is when market demand is very different than glass supply and our competition moves more aggressively on price in a given quarter. We are usually more restrained in our reaction. That's what tends to open up the gap. Just want to make sure logic flow we're all seeing it the same way.

Speaker 6

Got it. That's very helpful. Switching gears real quickly, any new perspectives on capital spending relative to what you guys were talking about at the analysts day? I think $1.8 billion this year and $1.2 to $1.3 billion for next.

Speaker 5

I'll not change that. We still expect a decline in 2013. You should count on those numbers.

Speaker 6

Thanks. Great. Operators can recognize we're coming up on the market open. I want to be respectful of people's time, so we'll take one more call.

Speaker 7

Our last question comes from the line of Wamsi Mohan from Bank of America. Please go ahead.

Speaker 1

Yes. Thanks a lot. Good morning. Can you give us maybe some indication of concentration now in Gorilla Glass versus where you were a year ago? You know, there were a lot more devices that were being launched, new devices. It seems like a lot of them have really not met with market success. It's been concentrated with a few key players that really have shown success. I'm trying to understand if we should expect significant volatility in this business outside of the supply chain issues that Wendell alluded to earlier. What risk, if any, do you see from any substitution of alternative materials? I have a follow-up.

Speaker 5

I'll comment on concentration. I think that in smartphones, we're seeing demand by a number of players. The things that you referred to last year really were the launch of the early tablets by some people who didn't do that well. We're seeing broad-based demand in smartphones for Gorilla. Wendell, you want to comment on competition?

Speaker 2

Yeah. Competition continues to be about the same as it was last year, which is there has been competition throughout last year. There's competition now. We've been blessed with continuing to have a very strong position. The change between Gorilla Glass 1 and Gorilla Glass 2 has sort of reestablished an advantage again, enabling customers to go about 20% thinner and have the same strength. Following our classic model, which is do a combination of product leading innovation together with strong process work to develop a competitive cost advantage, that typical model for us continues to work right now in Gorilla. Hopefully, more innovation to come. Watch this space.

Speaker 1

Okay. Thanks, Wendell. As my follow-up here, you mentioned Oxide TFT several times today. I'm curious to get your opinion on the possibility of the use of lower quality alkali glass as one of the two sheets of glass if Oxide does become the backplane technology of choice. Thank you.

Speaker 2

That's a very good question. Oxide TFT is going to require two probably higher performance pieces of glass relative to what is used today. That mainly has to do with the backplane being more challenging. Since the backplane is more challenging, you're creating an overall sandwich, and you want to match the expansion rates between the top and the bottom of that device. If you have an alkali-containing glass in the top, first, you have the potential for poisoning in these relatively complicated electronics packages. Also, you have different rates of thermal expansion. Those factors will tend to bring you into a more concentrated approach of two pieces of technical glass. You hear the more one-piece, two-pieces of glass when you hear about OLEDs, especially those OLEDs that are a little bit lower pixel count and whether or not it's bottom emission or top emission.

Bottom emission has the potential to use a different encapsulant material other than glass because it's coming out the bottom. The top of it doesn't necessarily need to be transparent. Most of the work that we are seeing right now go on is leaning towards the technology node of two pieces of glass. This is going to be a continually evolving technology as the industry seeks true differentiation.

Speaker 1

Thank you for all the color.

Speaker 0

All right. Jim has a closing comment.

Speaker 5

Yeah. Just a couple of quick comments at the end. First of all, we're going to have a fairly robust investor relations schedule over the next month. There are actually four conferences. First, we'll be at the Jefferies Global Conference in New York City on May 8th. We'll be at the JPMorgan TMT Conference in Boston on May 15th. We'll be back in New York City at the Barclays TMT Conference on May 22nd. Finally, at the Bernstein Strategic Decisions Conference in New York City on May 31st. Hopefully, you gather we'll be on the road a lot. We would love to see you all in person. Lastly, our annual shareholder meeting is going to be held tomorrow right here in Corning, New York, starting at 11:00 A.M. If you happen to be in the Corning area, please stop by.

For those who can't, we will be audiocasting on the website for the speeches. To wrap up, we've just completed four months of the year, and we continue to feel very good about our results. Our non-display businesses are all performing well and continue to demonstrate the growth potential we've been anticipating. In display, we're more encouraged now than we were just a few months ago, especially on the pricing front. We're looking forward to continuing this momentum as we head into the second quarter, and we will continue to keep you updated along the way. Ken?

Speaker 4

Thank you, Jim. Thank you all for joining us today at Playback at the Call, available beginning at 10:30 A.M. Eastern time today. We'll run until 5:00 P.M. Eastern time on Wednesday, April 25, The listen dial is 800-475-6701. The access code is 244213. The audiocast, of course, is available on our website during that time. Operator, that concludes our call. Please disconnect all lines.

Speaker 7

Thank you.

Speaker 0

Thank you, Hope.